Written by

Pralhad Burli

Published

March 29, 2013

The Indian economy is experiencing one of its slowest periods of growth in nearly a decade. India’s GDP grew just 5.5 and 5.3 percent in the first two quarters of the 2012–2013 fiscal year, prompting the Central Statistical Organization to lower its growth estimate to a meager 5.0 percent for the year as a whole. Slower GDP growth is primarily attributable to a weakness in the industrial sector. The Index of Industrial Production (IIP) grew a mere 0.7 percent between April and December 2012, down from 3.7 percent for the corresponding period in 2011–2012. Meanwhile, growth in the agriculture sector has been slow after an erratic start to the monsoon season, which likely caused lower growth in allied sectors as well. Furthermore, cautious monetary policy and tight credit conditions put a lid on the possibility of an investment-led growth revival.

On February 28, 2013, the finance minister presented the Union Budget 2013–14. He highlighted that persistent and large deficits on the current account coupled with a substantial fiscal deficit pose significant challenges to the economy. Furthermore, inflation and low investments have dampened India’s growth prospects. India ran the risk of its sovereign rating being downgraded to junk status in the absence of a clear fiscal consolidation plan. In his budget speech, the finance minister reaffirmed a commitment to continue on the fiscal roadmap laid out during the last year that would limit India’s fiscal deficit to 4.8 percent of GDP in the 2013–2014 fiscal through measures that rely largely on expenditure cuts and disinvestment proceeds. However, the success of the fiscal consolidation plan is largely dependent on the underlying assumptions, and the threat of a sovereign downgrade has not been entirely averted.

Meanwhile, India’s current account deficit rose to 5.4 percent of GDP in the second quarter of the 2012–2013 fiscal year, taking the deficit for the first half of 2012–2013 to 4.6 percent. Export growth fell faster than imports during the second quarter. So far, the current account deficit has been financed without drawing down reserves. While foreign direct investments (FDI) have declined in the first three quarters of 2012–2013 compared to the previous year, foreign portfolio investments have registered a healthy increase. A global recovery and an uptick in external demand will likely support a revival in the export sector, which augurs well for the economy. However, India’s import basket, which consists largely of petroleum imports, will likely continue to exert pressure on the country’s current account.

India’s growth rate appears to have bottomed-out, and the tide is likely to turn in India’s favor. The government hopes that its recent push for reforms will help trigger investments and jumpstart the economy.

In its third-quarter monetary policy meeting held on January 29, the Reserve Bank of India (RBI) cut its policy rate by 25 basis points, the first instance where the central bank tinkered with policy rate since April 2012. Meanwhile, wholesale price index (WPI) based inflation fell to 6.62 percent in January 2013, its lowest level since December 2009. The declining trend in the WPI is certainly a positive sign for the economy, but a majority of the decline is due to a moderation in non-food manufacturing inflation.

On the other hand, food prices remain elevated and are an area of concern. Unlike the previous year, when food inflation was mainly driven by higher prices of protein foods, the price of cereals has exerted upward pressure this year. Rising food inflation has widened the gap between inflation measured using the WPI index and the consumer price index (CPI) to over 4 percent in January 2013, primarily on account of higher weightage given to food items in CPI. India continues to witness double digit CPI inflation, which stood at 10.79 percent in January following a reading of 10.56 in December2012.

India’s growth rate appears to have bottomed-out, and the tide is likely to turn in India’s favor. The government hopes that its recent push for reforms will help trigger investments and jumpstart the economy. Based on current forecasts, the economy is expected to achieve a growth rate of 6.1–6.7 percent in the fiscal year beginning in April 2013.